CONSTRUCTION ECONOMICS

CONSTRUCTION ECONOMICS

LECTURE NOTES



CONSTRUCTION ECONOMICS

LECTURE NOTES

1

PAGE CONTENT

TOPIC TOPIC TITLE PAGE

1 ECONOMIC FOR HOUSING DEVELOPMENT 4

2 CASH FLOW 10

3 CURRENT PRICE AND FLUCTUATION COST 19

4 COST PLANNING AND COST CONTROL 24

5 COST IMPLICATION DUE TO DESIGN 28
CHANGES

6 FUNCTIONAL REQUIREMENT AND COST

IMPLICATION FOR CONSTRUCTION 33

METHOD

7 QUIZ 1 65
.
67
8 QUIZ 2 70

9 REFERENCES

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TOPIC 1

ECONOMIC FOR HOUSING
DEVELOPMENT

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CONSTRUCTION ECONOMICS: TOPIC 1

FEASIBILITY STUDY

Definition:
• ‘Feasible’ means practical, viable or possible.
• The essence of feasibility study therefore is a study on what is practical or viable or
possible.
• A feasibility study acts as one of the evaluation techniques that helps in decision
making.

Feasibility Study is carried out to show:
1. WHETHER OR NOT THE PROJECT OR ACTION TAKEN IS APPROPRIATE.
2. WHICH ALTERNATIVE ON ITS LIST IS THE BEST TO PURSUE.
3. WHAT ALTERNATIVE / OPTION ARE AVAILABLE.
4. HOW BEST TO EXECUTE THEM.
5. FROM A SELECTION OF ALTERNATIVES; WHAT IS THE ORDER OF MERIT.
6. WHAT WILL BE THE POSSIBLE RESULTS FROM THE DECISION MADE.

➢ Feasibility Study
o Profit is not the only main objective of Feasibility Study.
o Such economic study that provides relevant information that needs to be
given further emphasis like the consequences of infrastructure and
environmental projects.

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CONSTRUCTION ECONOMICS: TOPIC 1
➢ Categories of Feasibility Study
➢ Types of Feasibility Study

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CONSTRUCTION ECONOMICS: TOPIC 1
➢ Objectives of economic analysis

➢ Preparation process of FS

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CONSTRUCTION ECONOMICS: TOPIC 1
➢ Cost to be considered in the preparation of Feasibility Study

DEVELOPMENT PROCESS

• Land is the main resources for development.
• The size, condition, and type of land influence the type of development to be produced.
• Demand for land changes over time, WHY?

1. Increase population size that cause demand for buildings to increase.
2. Changes in income and preference of the population for something better which

results in demand for more comfortable and quality buildings.
3. Changes in the growth rate of economic activities at local or national level.
4. Changes in methods of transportation from traditional to a more efficient and

modern system.
5. Changes in production technique and distribution that are more efficient and need

shorter time.
• LOCAL AUTHORITY is the party that approving the development in certain area. E.g

DBKK, MPSJ etc.

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CONSTRUCTION ECONOMICS: TOPIC 1
➢ The development process in Malaysia has 5 stages:

o STAGE 1: Acquisition of Land
o STAGE 2: Application for planning Approval
o STAGE 3: Application For Conversion and Subdivision Land
o STAGE 4: Application for Building Plan Approval
o STAGE 5: Application for Certificate of Completion and Compliance (CCC)
➢ BUYING HOUSE PROCESS

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TOPIC 2

CASH FLOW

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CONSTRUCTION ECONOMICS: TOPIC 2

CASH FLOW

Definition:
• Movement of money into or out of a business, project, or financial product.
• Shows ability of a business: able to pay all liabilities [loan, creditor's claim &
spending].
• Defined as cash-in and cash-out of any transaction.
• Can be attributed to a specific project, or to a business as a whole.
• Cash flow can be used as an indication of a company's financial strength.

i. INFORMATION REQUIRES IN PREPARING CASH FLOW
ii. TYPES OF CASH FLOW.
iii. ITEMS COMPRISE IN CASH FLOW.
iv. IMPORTANCE OF CASH FLOW.
v. USES OF CASH FLOW IN COST FORECASTING.

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CONSTRUCTION ECONOMICS: TOPIC 2
1. INFORMATION REQUIRES IN PREPARING CASH FLOW
➢ The minimum information required for this type of software is:
o The contract sum
o The contract period
o The amount of retention
o An estimated percentage completion at practical completion stage
o The length of the defects period
➢ Software will produce a tabulated printout showing estimated payments that the
client should expect to make a graphical representation of the figures.
➢ Future payments can be adjusted to accommodate actual payments & any
revisions to the length of the contract period can be made.
2. TYPES OF CASH FLOW
➢ OPERATING ACTIVITIES - Day-to-day operations
➢ INVESTING ACTIVITIES - Long-term assets
➢ FINANCING ACTIVITIES - Equity & long-term liabilities

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CONSTRUCTION ECONOMICS: TOPIC 2

3. Cash inflow
• Sums of money received by a business during a period of time.
• Shows the inflow of money earned by the client to implement development
projects.
• Client will know the financial resources.
• Total income of the client can be known and compared with an outflow of client
expenses.
• If inflows exceed outflows, then it will show the profits earned during the project
run.

4. Cash outflow
• The sums of money, paid out by a business during a period of time.
• Shows the amount of money out of the month / annual.
• Client can know the total expenses.
• Client expenditure can be known and compared with inflows of client income.
• If outflows exceed inflows, then it will show a loss obtained during the project
run.

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CONSTRUCTION ECONOMICS: TOPIC 2

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CONSTRUCTION ECONOMICS: TOPIC 2

5. IMPORTANCE OF CASH FLOW IN PROJECT PLANNING & PROJECT FINANCING

• Investment basics.
• Know when project will produce income.
• Reflection the projects strength and profitability.
• Saves unnecessary expenditure.
• Keep you out of debt.
• Ensures timely payment.
• Income Assurance.
• Understand fund movement.

6. IMPORTANCE OF CASH FLOW IN PROJECT FINANCING

i. Income assurance
• The biggest importance of cash flow is that the business or organization
tends to have an assured income irrespective of the outside economic
condition.

ii. Ensures timely payment
• The uniform and assured cash flow, in both the directions, ensures two
principal payments, namely, the salaries of employees are paid on time
and instalments of all loans are made on time. This safeguards the trust
of employees and upholds the credit rating.

iii. Keep you out of debt.
• The timely cash inflow plays a very instrumental role in keeping you
out of debt, as a timely inflow of cash prevents you from taking small
loans.

iv. Saves unnecessary expenditure.
• Use of inward and outward cash flow, prevents all unnecessary
expenditure such as piled up interest, late payment charges, etc.

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CONSTRUCTION ECONOMICS: TOPIC 2

7. IMPORTANCE OF CASH FLOW IN PROJECT PLANNING & PROJECT FINANCING
i. Investment basics
• As a basis for investors to evaluate financial performance in terms of
developers in implementing a project.
• Monetary policy developers scrutinized based on business cash flow.
• If cash flow positive the developers, the opportunity to obtain
financing is high.
• If negative cash flow - potential will get financing thin.
ii. Understand fund movement.
• Shows how the company has acquired the source of funds to buy
assets - new assets, pay dividends and repay debts.
• Shows how developers use the funds for planning future activities and
control activities.
• Help developers obtain financing when funds are sufficient to cover
the activities of all developers - collateral if the developer facing
financial difficulties.
iii. Reflection the projects strength and profitability.
• If cash flow is actually not adjusted as planned, it will have adverse
effects on the overall project plan.
• For example, obtaining more loans than needed at earlier stage will
result in expenses to pay more interest.
• And if the loan is obtained too little and too late it will stop doing
business or project can not run smoothly.
iv. Know when project will produce income.
• So, when compared to the income, we will be able to know at a
certain time the projects are facing a cash surplus or deficit and how
much.
• If lack of cash, we will be able to know when the loan is needed and
how much.
• From surplus cash we will know when the loan can be paid and how
much.

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CONSTRUCTION ECONOMICS: TOPIC 2
8. USES OF CASH FLOW in cost forecasting
❖ Also called cash flow budget/cash flow projection.
❖ helps identify whether a firm needs to borrow, how much, when, & how it
will repay the loan.
➢ Cash flow forecast is an important business tool for every business.
➢ Forecast establishes whether there is enough cash to run the business or to
expand it.
➢ Allows an evaluation of cash resources that are required and when they are
required by.
➢ Business owners can identify likely future gaps in funding and plan for those gaps
accordingly.
9. CONTRACTOR’S CASH FLOW FORECAST

Contractor is in a +ve cash flow position & the amount of money that will need to be financed
each month. The vertical lines each month indicate the size of the payment that has been
received from the client.

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CONSTRUCTION ECONOMICS: TOPIC 2
➢ Many contracting companies use planning software to establish their programme of
works and to allocate resources to the project.
➢ This include the financial resource as well labour, plant & materials.
➢ The various delays in paying labour, subcontractors, materials suppliers & plant
providers are taken into considerations.
➢ By good financial management the contractor may well be able to achieve a +ve cash
flow earlier.

10. WHY PREPARE CASH FLOW FORECAST?
• TO PLAN YOUR CASH STRATEGY.
• DEVELOP ACCURATE INVESTMENT DECISIONS.
• PROVIDE AN “EARLY WARNING” OF CASH SHORTAGES.
• ASSURE INVESTORS OF YOUR CASH PROJECTIONS.
• ASSIST IN CASH NEGOTIATIONS WITH CREDITORS.
• PINPOINT DEBTOR ISSUES.
• RUN OPTIONS - STRESS TEST YOUR CASH POSITION.

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TOPIC 3

CURRENT PRICE AND
FLUCTUATION COST

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CONSTRUCTION ECONOMICS: TOPIC 3

CURRENT PRICE & FLUCTUATION
COST

Definition:
i. FLUCTUATION COST?
• The increase & decrease of price.
• The movement of price.

ii. CURRENT PRICE?
• Price at which something is selling at the present time.

Situation
Contractor who tenders at a fixed price run the risk that he

may later have to pay more
(For materials, labour than the prices & wages current at

the time of his tender)
Conversely, he may benefit if those prices & wages go down)

CAUSES OF FLUCTUATION COST
a. MARKET CONDITION
i. When there is sudden change in obtaining the materials; the cost of the project
goes up. e.g. Steel price in the recent past has gone up very rapidly due to
short supply of steel in the world market.
ii. Sudden increase in the fuel price in the world market will intern increase the
cost of construction. When the fuel prices increases, the following will also
automatically increases.
iii. Hiring charge or Operation charge of the machines goes up.
iv. Transportation cost goes up.

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CONSTRUCTION ECONOMICS: TOPIC 3

v. Material production cost goes up.
b. DEMAND

i. Demand greatly influence the cost of an element changes.
ii. In economic terms, demand raise the price of an element if otherwise this

element will experience a decrease in value.
c. TECHNOLOGICAL CHANGE

i. Better use of technology in terms of cost & time influence of price changes
• E.g. wood to replace steel in some aspects of the construction.

d. EXPERTISE OF MANPOWER
i. Skilled labour will lead to price changes in construction contracts.

Importance of current price & fluctuation cost in construction works
➢ In determining the price during the tender price;
o If budget estimate is too high, causing the client to discontinue the project
o If budget is too low/ price given is below the consultant estimated ; the client
may loss.
➢ Current prices can prevent the contractor from making a loss.
➢ Allow the QS to make cost analysis effectively.

Basis of using current price in cost estimation
➢ Reasonable price contracts allow contractors to compete with other contractors to
win the construction tender.
➢ QS get the latest prices based on cost data.
➢ Allows QS provide accurate advice to clients about the risks; if a material experiencing
price increases in the future.
➢ Avoid incurring a loss if the contractor offers a price that is not accurate.

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CONSTRUCTION ECONOMICS: TOPIC 3

Consideration to undertake the fluctuation of materials cost

i. Change specifications
ii. Reduce the purchase price of building materials during price increase. buy more

materials when prices fall.
iii. Change construction projects plan.
iv. Distribution of costs for the building element need to be restructured.

GOVERNMENT INTERVENTION IN THE MARKET
❖ Introduction to Variation of Price (vop)
o A variation (sometimes referred to as a variation instruction, variation order or
change order) is an alteration to the scope of works in a construction contract
in the form of an addition, substitution or omission from the original scope of
works.
o This can be because of :
▪ Technological advancement.
▪ Statutory changes or enforcement.
▪ Change in conditions.
▪ Geological anomalies.
▪ Non-availability of specified materials.
▪ Or simply because of the continued development of the design after
the contract has been awarded.
o The Variation of Prices exercise must be carried out in every Interim Payment,
and the final adjustment is made after the whole of the Works is completed.
o For Civil Works, ensure the adjustments made must not exceed the quantities
allowed in Contract.
o The valuation and calculation must be in accordance with the Special
Provisions (Siaran Khas) to the Conditions of Contract.
o The net total of any such increases or decreases shall be added to or deducted
from the Contract Sum as the case may be.

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CONSTRUCTION ECONOMICS: TOPIC 3
❖ Valuation of variations
o Variations may give rise to additions or deductions from the contract
sum.
o The valuation of variations may include not just the work which the
variation instruction describes, but other expenses that may result
from the variation, such as the impact on other aspects of the works.
o Variations may also (but not necessarily) require adjustment of the
completion date.
o Variations may be valued by:
▪ Agreement between the contractor and the client.
▪ The cost consultant.
▪ A variation quotation prepared by the contractor and accepted by the
client.
▪ By some other method agreed by the contractor and the client.

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TOPIC 4

COST PLANNING AND
COST CONTROL

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CONSTRUCTION ECONOMICS: TOPIC 4

COST PLANNING

Definition:
➢ The use of the term “cost planning” starts from the inception stage of the project until
the project is handed over to the construction.
➢ The post contract is known as cost control stage.
➢ It is quite common that the terms cost planning and cost control overlap and is used
simultaneously.
➢ It is a system that requires total coordination of the project from its commencement
to completion.
➢ It involves a systematic framework procedure and demands high commitment from
the design team to cooperate with the QS to ensure that the objectives in terms of
cost, time and quality are achieved.

A GOOD COST PLANNING SHOULD:
➢ Ensure the tender figure is as close as possible to the first estimate, or that any likely
differences between the two is anticipated and within an acceptable range.
➢ Ensure that the funds available for the project are allocated effectively and
economically to the various elements and sub-elements.
➢ Always involve the measurement and pricing of approximate qty at some stages of the
process.
➢ Aim to achieve good value at the desired level of expenditure.

PURPOSE OF COST PLANNING

i. Ensuring the client receive value for money, not necessarily lower than the initial cost.
There must be a balance between quality, Usage suitability, initial cost and life-cycle-
cost for the entire lifespan of the element.

ii. Ensuring both the client and designer are aware of the implications of their decision
on cost.

iii. Providing advice to the designer to enable him to design within the budget.

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CONSTRUCTION ECONOMICS: TOPIC 4

iv. To ensure the tender sum could be within the budget of the client. This will avoid
project being aborted.

v. A reasonable expenditure between sections of the building by relating the design and
specification to the client’s budget so that a more balanced design is obtained.

❖ In addition, cost planning is important to control building cost at the design stages. The
Tender cost should be lower than the planning cost.
i. This ensure that client and the design team knew the design of proposed building
within cost limit.
ii. Greater satisfaction with end results.
iii. Better value for money.
iv. Improved building quality and performance.
v. Budget and value accountability.
vi. Improved relationships between all project participants.
vii. Design problems identified and solved earlier.
viii. Early identification of high-cost elements.

METHODS IN COST PLANNING
1. Elemental cost planning
a. Cost Planning by Element.
b. Cost Target Plan.
c. Design to Cost.
2. Comparison cost planning
a. Cost Planning by Comparatively.
b. Cost to Design

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CONSTRUCTION ECONOMICS: TOPIC 4
ELEMENTAL COST PLANNING

➢ It is a system of cost planning & cost control, typically for buildings, which enables
the cost of a scheme to be monitored during design development.

➢ Elemental cost planning is often referred to as 'designing to a cost' or 'target cost
planning' since a cost limit is fixed for the scheme and the architect must then
prepare a design not to exceed this cost.

COMPARATIVE COST PLANNING
➢ Different design will give different cost implication.
➢ The object is to achieve economy of design by investigating a range of design.
➢ Proposals and establishing a combination of element designs which best meet the
clients requirements for standard etc.
➢ Also known as ‘pricing according to design’, where cost plan are prepared according
to the design that have been made/selected.
➢ Usually, architect will design more than one alternative to meet the client
requirement.

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TOPIC 5

COST IMPLICATION DUE
TO DESIGN CHANGES

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CONSTRUCTION ECONOMICS: TOPIC 5

COST CONTROL

Definition:
➢ Embrace all methods of controlling the cost of a project from its inception to
completion.
➢ According to Nunally (1998), cost control of a project involves the measuring and
collecting the cost record of a project and the work progress.

Cost Control
➢ The MAIN objectives of cost control of a project is to gain a maximum profit within
the designated period and satisfactory quality of work.
➢ A systematic procedure of cost control will give a good result in collecting important
cost data in estimating and controlling of the cost of the coming project in future.
➢ The implementation of effective cost control procedure enables the architect to be
kept fully informed of the cost implication of all his design decision.
➢ It necessitates close collaboration between the architect , quantity surveyor, and any
other consultants that have been engaged throughout the design stage.

Purpose of Cost Control
i. To give the building client good value for money.
ii. Ensuring both the client and designer are aware of the implications of their decision
on cost.
iii. Integrating cost with time and quality.
iv. To achieve a balanced and logical distribution of the available funds between the
various parts of the building.
v. Providing advice to the designer to enable him to design within the budget.

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CONSTRUCTION ECONOMICS: TOPIC 5

ROLES OF QS in planning stage
• Building cost today are more detail with the use of more skills and accuracy, because
building have become larger, more complex and sophisticated, and more costly while
the clients have become more specific of their project requirement.
• This is because the total cost of a project has been decided on earlier at the initial
stage of design.
• The architects are also required to give more attention on planning procedure and
cost control and they are encouraged to seek advice from the quantity surveyor.

ROLES OF QS in planning & design stage
1. PLANNING STAGE
a. INCEPTION - determine project finance methods & client’s capacity.
b. FEASIBILITY - Feasibility Report & Cost Limit.
c. OUTLINE PROPOSAL - Outline Cost Plan.

2. DESIGN STAGE
a. SCHEME DESIGN - Detailed Cost Plan.
b. DETAIL DESIGN - Comparative Cost Study & Cost Check by comparing the
Detailed Cost Plan with the design proposal.

ROLES OF QS in design stage
➢ In effort to control the cost more effectively, the QS must have full understanding of
the design processes.
➢ QS keeps large sources large sources of cost data from readily completed building that
are different in design and structures, different in services offered, & use different
materials and components.
➢ Moreover, QS is aware of the cost implications due to changes in the design factor like
shape, height and other feature of the building.
➢ This brings to everyone’s attention that the information needs to be channeled back
to the design process.

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CONSTRUCTION ECONOMICS: TOPIC 5

ECONOMICAL MANAGEMENT OF TENDERS & CONTRACTS
➢ Contract management success factors, the conditions that should be met if a contract
is to be managed successfully, are:
o The arrangements for service delivery continue to be satisfactory to both
customer and provider.
o Expected business benefits and value for money are being realised.
o The provider is cooperative and responsive.
o The customer knows its obligations under the contract.
o There are no disputes.
o There are no surprises.
o Satisfactory delivery progress is demonstrable.

General principles of tendering
i. Value for money.
ii. Open and fair competition.
iii. Accountability.
iv. Risk Management.
v. Probity and transparency.
vi. Local Industry Participation.
vii. Minimisation of tendering costs.

Cost Control Terminology
i. Cost Plan
• A cost statement in terms of how a designer intends to design each element
or part of a building.
ii. Cost Check
• Process of checking estimated cost of each section/element of building to the
detailed design developed, against the COST TARGET in the cost plan.

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CONSTRUCTION ECONOMICS: TOPIC 5
iii. Element
• Main element of a building that performs the same functions regardless of
difference in specification & design.
iv. Cost Limit
• Client’s maximum budget; according to client requirement.
v. Cost Analysis
• A systematic breakdown with ELEMENTS intended to facilitate the cost
checking.
vi. Cost Target
• Final agreed-upon cost which serves as a basis for budget allocation.
vii. Cost in use
• Total costs of building projects [initial capital, maintenance, running costs]
throughout the building’s life cycle.

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TOPIC 6

FUNTIONAL REQUIREMENT AND COST
IMPLICATION FOR CONSTRUCTION
METHOD

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Introduction

 The cost of a building is influenced by many
factors.

 The main objective of design team is to get the
best value for money for the client, not
necessarily the lowest but that is economical.

 An economical building is a building that does
not only give value at the lowest cost but also
fulfils the design and function required

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ECONOMICS OF
BUILDING DESIGN

Design Factor Site Factor
Building Plan Shape
Grouping of building Affect of site on building
size
Building Size
Building Storey Height Affect of site on design
Building Total Height of building
Changes in the number
Affect of site on plot
of storey ratio
Circulation Area
Affect of site on design

Affect of site location on
design

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DESIGN FACTOR

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1. Building Plan Shape

 The plan shape of a building influences the structure,
environment, construction cost and management and
maintenance cost of a building.

 The most economical design is circular in shape because it
provides bigger volume with minimum enclosing wall.

 However, it is not a design that is practical and its suitability
for building function is limited.

 A circular building also does not help in the economical use
of the site.

 In theory, a big-square building is the most economical, but
similar to a circular building.

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EXAMPLE
The construction of a single storey residential building can have several plan
shapes as shown below :

A B C

10m 5m 10m
10m
20 m 5m

5m

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BUILDING A BUILDING B BUILDING C

GFA (M2) 100 100 100
WALL AREA (M2) 40M X 4 = 160 50M X 4 = 200 50M X 4 = 200

WALL AREA / GFA 1.60 2.00 2.00

 Building A is the most economical as it has the lowest ratio
compared to buildings B and C. The higher the ratio the
higher the cost of a building because :

 There is an increase in measurement works,
foundations works, external walls, wall finishes etc

 Construction works become more complicated and this
increase labour costs.

 Installation works for electrical wiring, piping and air-
conditioning system also increase.

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 Roofing construction becomes more complex.
Installation such as rainwater drainage system, gutter,
fascia, barge board and eaves will increase.

 In terms of maintenance :

 Electrical cost is higher due to greater usage of
electricity to provide better lighting and air-conditioning

 Washing and cleaning cost increase because there are
more spaces and areas.

 Repainting cost, repairing and replacing wall finishes
increase.

 Elements outside the building are more exposed to
weather and will be more easily damaged.

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2. Grouping of buildings

 If the buildings are built or grouped together, there will be
generally savings in cost resulting from the combined use
or party walls.

 The party wall is shared together by two units of building.
 By grouping the buildings, changes in cost can be

examined.
 The effect of grouping of building is not only on the

external walls.
 By changing the layout/shape, the span of the roof

structure will have to be adjusted.
 This may effect the variation in the amount of timber or

concrete used.
 Installation of rainwater drainage will also differ.

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Floor Plan Ext Wall Party wall Shared Area PW Area Ext
Shared pw ext wall (1 UNIT) Wall(1
15m 15 + 15 + u)
10 + 10 = - Individual -
- ext wall = 50 X 4 =
50 200
50

10m

10 (3)(2) + 15 X 2 = 30 90 / 3 = 10 X 4m 30 X 4 =

15(2) = 90 30 H = 40 120

15m 30 / 3 = 10

10 10 10 15(2)(2) + 10 80 / 2 = 5 X 4m H 40 X 4 =
m m 15 m 40 = 20 160
m
15 10(2) = 80
m

10 10 10 / 2 = 5
mm

15 15 15 15 (3)(2) + 10 X 2 = 20 110 / 3 = 6.7 X 4m 36.7 X 4
m m m
10m 10(2) = 36.7 H = 26.8 = 146.8

110 20 / 3 = 6.7

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Floor Plan Area PW Area Ext PartyWal ExtWall Remarks
(1 UNIT) Wall(1 u) l Cost/m2
15m Cost/m2
- 50 X 4 = 200 x
200 - RM35 =
RM 7000

10m

15m 10 X 4m H 30 X 4 = 40 x 120 x The cost of
= 40 120 RM35 = RM35 = narrow
fronted

RM1400 RM 4200 building is
lower than

the broad

10 10 10 fronted
m 15 m 15 m
m 5 X 4m H = 40 X 4 = 20 x 160 x
m 20 160 RM35 = RM35 =

10 10 RM700 RM 5600
mm

15 15 15 6.7 X 4m 36.7 X 4 = 26.8 x 146.8 x * Broad

m m m 10m H = 26.8 146.8 RM35 = RM35 = fronted

RM938 RM 7000

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